In the working sections of the Supreme Court building in Washington, D.C., the quiet places where the justices have their chambers and the staffs go about their work, portraits of the former members of the court peer out from almost every room and hallway. I used to find myself, when I worked there some years ago, pausing beneath the past luminaries and wondering what they might have to say about the court's current cases.

I never got very far with Oliver Wendell Holmes (1841-1935). His portrait didn't invite inquiry. He sat straight-backed in his judicial robes, his lips pursed beneath a virile white mustache, eyes boring directly ahead. He conveyed simultaneously grandeur and skepticism, as if he might interrupt you at any moment to say, "That's nonsense." This is Holmes in his Solomonic pose, the man hailed as the "Master of Sentences," lionized in an early biography as the "Yankee from Olympus," his life made the subject of a 1950s Hollywood film. It was an image that Holmes spent nearly the whole of his adult life cultivating, driven on by his galloping ambition. "I should like to be admitted," he told a correspondent in 1912, "as the greatest jurist in the world."

Holmes would surely have approved of Thomas Healy's "The Great Dissent." The subtitle conveys the narrative's gist: "How Oliver Wendell Holmes Changed His Mind—and Changed the History of Free Speech in America." Mr. Healy recounts Holmes's emergence late in his career as a champion of free speech and tells the story of the coterie of young intellectuals, led by Felix Frankfurter and Harold Laski, who worked assiduously to shape Holmes's views. It is a fascinating tale—and a charming one, of an aging and childless Holmes befriended by a rising generation of legal thinkers, surrogate sons who persuade him over time to take up their cause.

Mr. Healy, a professor of law at Seton Hall, is at his best detailing the younger men's campaign to win Holmes to their view of the First Amendment. In March 1919, Holmes still believed that the government could punish "disloyal" speech and wrote an opinion supporting the 1917 Espionage Act, which made it illegal to criticize the draft or American involvement in World War I. In Debs v. United States, the Supreme Court unanimously upheld the prosecution of Socialist Party leader Eugene Debs for his critical statements about the war. Less than nine months later, Holmes had changed his mind, dramatically. In Abrams v. United States, he broke with his colleagues and with his own earlier views and argued that the Constitution didn't permit the government to punish speech unless it posed a "clear and present danger" of public harm. Laws penalizing any other type of public speech were unconstitutional. Holmes's Abrams opinion is the "great dissent" of Mr. Healy's title.

The youthful acolytes had made the difference. As Mr. Healy elaborates, Holmes had developed a knack for collecting young admirers in his years on the Supreme Court (1902-32). In 1919, Holmes's circle included Frankfurter, a junior professor at Harvard Law School serving in the Wilson administration, and the Englishman Harold Laski, just 25 and like Frankfurter a Jew and a teacher at Harvard. Both men would go on to illustrious careers—Frankfurter on the Supreme Court and Laski as a political theorist and chairman of the British Labour Party. Both admired Holmes for his modernist intellectual outlook: for his skepticism about moral absolutes and dislike of formal legal doctrine; and for what they believed (mistakenly) to be Holmes's progressive political views.

Even before the Debs case, Laski had been plying Holmes with arguments about free speech. After Holmes's disappointing opinion in that case, Laski redoubled his efforts, assisted by letters from Frankfurter and well-timed essays from the pair's allies at the New Republic magazine. As it happened, both Laski and Frankfurter suffered professionally in 1919 for their sometimes outspoken political views—both were briefly in danger of being dismissed from Harvard. Mr. Healy implies that their ordeal may have heightened Holmes's appreciation for free speech. But the more likely turning point came in the summer of 1919, when Laski forwarded to Holmes an article defending freedom of speech for its social value and then introduced Holmes to its author, another young Harvard law professor named Zechariah Chafee Jr.

Chafee, who was no sort of progressive and whose specialty was business law, argued that free speech advanced a vital social interest by promoting the discovery and spread of truth, which in turn allowed democracy to function. Holmes had never been much of a proponent of individual liberty, but he was profoundly committed to majoritarian democracy. Free speech as a social good was a rationale he could buy. And in his Abrams dissent a few months later, he did. He would eventually conclude that the First Amendment shielded speech from both federal and state interference.

Mr. Healy tells this conversion story well, bringing the reader into Holmes's confidence and into the uneasy, war-weary milieu of 1919 America. "The Great Dissent" is compelling, too, for the glimpses it gives of the human Holmes rather than the Olympian public figure. Here is Holmes standing at his writing desk to compose his court opinions, keeping them brief lest his legs tire; waxing rhapsodic each spring about the bloodroot flowers in Rock Creek Park. He was unfailingly decorous to his colleagues—even as he was indifferent to his wife—but quivered and fumed at the merest hint of criticism, unable to acknowledge that he had ever been mistaken about anything of importance.

All too often, however, Mr. Healy lapses into hagiography and an annoyingly Whiggish mode of storytelling, in which our modern free-speech doctrine —which protects the right of individuals and corporations to speak on most any topic at most any time—is portrayed as the Inevitable Truth toward which constitutional history has been marching all along. In this story, Holmes's embrace of free speech emerges as the very culmination of his life's work and its linchpin. "It was almost as if Holmes had been working toward this moment his entire career," Mr. Healy says triumphantly.

Not quite. Holmes's endorsement of free speech as a constitutional principle was far more ambivalent than Mr. Healy lets on and in considerable tension with the rest of his jurisprudence. This is precisely what makes it so interesting. Holmes's struggle to reconcile freedom of speech with his other legal ideas helped him to see connections that contemporary Americans are apt to miss.

Holmes made his name on the court as an advocate of judicial restraint. He thought courts should overturn the judgment of democratic legislatures in only the most extraordinary of circumstances. He was a skeptic. He believed law didn't have much to do with morality—"absolute truth is a mirage," he once said—or even logic. As he saw it, law was nothing more than "the dominant opinion of society." The Constitution placed no firm bounds on the right of the majority to do as it pleased. It was "made for people of fundamentally differing views," he said. The majority could choose the view and pursue the policies it wanted, for the reasons it wanted.

All this being true, the judiciary had no business substituting its views for those of the public. If law was based merely on opinion and raw preference, the people's preferences should count, not judges'.

How then did Holmes come to hold that the First Amendment could be used to strike down laws of Congress and even of the states? The answer is that Holmes came to see the principle of free speech as an essential part of majority rule; it was valuable because it helped majorities get their way.

Mr. Healy notes the influence on Holmes of Chafee's "social argument" for free speech but fails to explain just how central it was to his conversion experience. In his dissenting opinion in Abrams, Holmes wrote: "The best test of truth is the power of the thought to get itself accepted in the competition of the market." Truth was whatever the majority thought it was, but if the majority was going to make up its mind in a sensible way, it needed to have as many options before it as possible. Then too, majorities changed their minds, and protecting speech that was unpopular now preserved opinions that the majority might come to favor in the future. "The only meaning of free speech," Holmes wrote in 1925, is that every idea "be given a chance" to become in time the majority creed.

Such reasoning tethered free speech to majority rule, but it was less than perfectly consistent. Even as he valorized the right to speak, Holmes continued to insist that "the dominant forces in the community" must get what they wanted. Yet if free speech were to mean anything at all as a constitutional right, it would mean that majorities could not get their way in all circumstances. From time to time, Holmes recognized as much; in one of his last opinions he wrote that the "principle of free thought" means at bottom "freedom for the thought we hate." How forcing the majority to tolerate speech it hated facilitated that same majority's right to have its way is a formula Holmes never quite explained.

Mr. Healy suggests that with Holmes's dissent in Abrams, the modern era of First Amendment law had arrived. But Holmes's majoritarianism didn't prevail as the principal rationale for free speech at the Supreme Court, which has instead emphasized individuals' right to speak regardless of the social interests involved. Still, for all its internal tensions, Holmes's unfinished view—he continued to puzzle over the problem right through his retirement from the court in 1932—captures something that the contemporary adulation of free speech has hidden.

Holmes saw that the Constitution's commitment to freedom of speech is inextricably bound up with the project of self-government that the Constitution was designed to make possible. That project depends on an open exchange of ideas, on discussion between citizens and their representatives, on the ability of everyday Americans to talk and reason together.

This sort of government is a way of life, and the First Amendment helps makes it possible by prohibiting the state from censoring the organs of social communication. The government may not control newspapers or printing presses or stop citizens from stating their views. Government may not halt the dissemination of ideas.

In the past half-century, however, the Supreme Court has increasingly spoken of the right to free speech as a right to free expression. Under that rubric, it has expanded the First Amendment to cover all manner of things unconnected to public life, be it art or pornography or commercial advertising. This trend has been even more pronounced in popular culture, where the right to express oneself is now widely regarded as the essence of the freedom to speak.

And to be sure, individual expression is a valuable thing. The danger is in coming to think of free speech as merely expression. That reductionism encourages Americans to see freedom of speech, and freedom generally, as mainly about the pursuit of private aims. But in the end, such thinking represents a loss of confidence, or worse, a loss of interest in the way of living that is self-government—in the shared decisions and mutual persuasion that is how a free people makes a life together. Ours is a country saturated with talk and shouted opinions and personal exhibitionism but one less and less interested in the shared civil discourse that democracy requires.

Holmes wouldn't have described free speech or self-government in such elevated terms. He was too much the skeptic for that. But he came to understand, in his own way, the profound value of free speech to a free people. The story of this discovery is worth revisiting.

—Mr. Hawley, an associate professor of law at the University of Missouri and former judicial clerk to Chief Justice of the United States John G. Roberts Jr., is the author of "Theodore Roosevelt: Preacher of Righteousness" (2008).

In this report, the MAGD focuses on the effects of (i) mandatory
central clearing of standardised OTC derivatives, (ii) margin
requirements for non-centrally cleared OTC derivatives and (iii) bank
capital requirements for derivatives-related exposures. In its preferred
scenario, the Group found economic benefits worth 0.16% of GDP per year
from avoiding financial crises.

It also found economic costs of 0.04%
of GDP per year from institutions passing on the expense of holding more
capital and collateral to the broader economy. This results in net
benefits of 0.12% of GDP per year. These are estimates of the long-run
consequences of the reforms, which are expected to apply once they have
been fully implemented and had their full economic effects.

The MAGD was set up by the OTC Derivatives Coordination Group
(ODCG), comprised of the Chairs of the Basel Committee on Banking
Supervision (BCBS), the Committee on the Global Financial System (CGFS),
the Committee on Payment and Settlement Systems (CPSS), the Financial
Stability Board (FSB) and the International Organization of Securities
Commissions (IOSCO). It comprises financial and economic modelling
experts from 29 central banks and other authorities, chaired by Stephen
Cecchetti, Economic Adviser of the Bank for International Settlements
(BIS).

Executive summary (excerpts)

In February 2013, the Over-the-counter Derivatives Coordination Group (ODCG) commissioned a quantitative assessment of the macroeconomic implications of over-the-counter (OTC) derivatives regulatory reforms to be undertaken by the Macroeconomic Assessment Group on Derivatives (MAGD), chaired by Stephen G Cecchetti of the Bank for International Settlements (BIS). The Group comprised 29 member institutions of the Financial Stability Board (FSB), working in close collaboration with the IMF. Guided by academics and other official sector working groups, and in consultation with private sector OTC derivatives users and infrastructure providers, the Group developed and employed models that provide an estimate of the benefits and costs of the proposed reforms. This report presents those findings.

Counterparty exposures related to derivatives traded bilaterally in OTC markets helped propagate and amplify the global financial crisis that erupted in 2008. Many of these exposures were not collateralised, so OTC derivatives users recorded losses as counterparty defaults became more likely or, as in the case of Lehman Brothers, were realised. Furthermore, since third parties had little information about the bilateral exposures among derivatives users, they became less willing to provide credit to institutions that might face such losses.

In response, policymakers have developed and are implementing reforms aimed at reducing counterparty risk in the OTC derivatives market. These include requirements for standardised OTC derivatives to be cleared through central counterparties (CCPs), requirements for collateral to be posted against both current and potential future counterparty exposures, whether centrally cleared or non-centrally cleared, and requirements that banks hold additional capital against their uncollateralised derivative exposures.

While these reforms have clear benefits, they do entail costs. Requiring OTC derivatives users to hold more high-quality, low-yielding assets as collateral lowers their income. Similarly, holding more capital means switching from lower-cost debt to higher-cost equity financing. Although these balance sheet changes reduce risk to debt and equity investors, risk-adjusted returns may still fall. As a consequence, institutions may pass on higher costs to the broader economy in the form of increased prices.

This report assesses and compares the economic benefits and costs of the planned OTC derivatives regulatory reforms. The focus throughout is on the consequences for output in the long run, ie when the reforms have been fully implemented and their full economic effects realised. The main beneficial effect is a reduction in forgone output resulting from a lower frequency of financial crises propagated by OTC derivatives exposures, while the main cost is a reduction in economic activity resulting from higher prices of risk transfer and other financial services.

These long-run benefits and costs depend on how the reforms interact with derivatives portfolios and affect the structure of the derivatives market more broadly, as this can significantly alter the amount of netting obtainable from gross counterparty exposures. In response, the Group analysed three scenarios that differ mainly in terms of the assumed degree of netting. [...]

Briefly, the main benefit of the reforms arises from reducing counterparty exposures, both through netting as central clearing becomes more widespread and through more comprehensive collateralisation. The Group estimates that in the central scenario this lowers the annual probability of a financial crisis propagated by OTC derivatives by 0.26 percentage points. With the present value of a typical crisis estimated to cost 60% of one year’s GDP, this means that the reforms help avoid losses equal to (0.26 x 60% =) 0.16% of GDP per year. The benefit is balanced against the costs to derivatives users of holding more capital and collateral. Assuming this is passed on to the broader economy, the Group estimates that the cost is equivalent to a 0.08 percentage point increase in the cost of outstanding credit. Using a suite of macroeconomic models, the Group estimates that this will lower annual GDP by 0.04%. Taken together, this leads to the Group’s primary result: the net benefit of reforms is roughly 0.12% of GDP per year.

As one would expect, for the scenarios with higher and lower netting these net benefits are respectively slightly higher and slightly lower. Importantly, the Group concludes that the economic benefits are essentially constant across scenarios because the reforms demand collateralisation of the vast majority of net counterparty exposures, whatever their size. But shifting between netting and collateralisation does affect the estimated costs and hence the net benefits.

Uncertainties arising from a combination of modelling limitations and data scarcity were handled in a variety of ways. First, examining a variety of macroeconomic models helped the Group to improve the precision of estimates of the impact of the reforms’ direct costs on the real economy. Second, by varying the structure of the network of bilateral OTC derivatives exposures within feasible limits as well as the strength of the relationship between losses on these exposures and the creditworthiness of the institution incurring them, the Group managed two other potentially large uncertainties. And finally, while some assumptions bias the results towards higher net benefits, many deliberately bias them in the other direction. For example, the funding costs of increased collateral and capital holdings were based on historical prices, rather than prices that reflect improvements in credit quality associated with these balance sheet changes.

In the course of completing the analysis reported here, the Group encountered a number of technical challenges. One related to a shortage of information about the structure of the OTC derivatives exposure network. In the absence of data on bilateral exposures, these were estimated using aggregate data and distributional assumptions. Conversations with derivatives users, infrastructure providers and regulators then helped to validate the estimated network. More generally, the Group found little prior analysis of how derivatives can affect the economy.

Despite statistical uncertainty and the need to make various modelling assumptions and to employ only the limited data available, the group concludes that the economic benefits of reforms are likely to exceed their costs, especially in the scenarios with more netting. Therefore, to maximise the net benefit of the reforms, regulators and market participants must work to make as many OTC derivatives as possible safely centrally clearable, with either a modest number of central counterparties or with central counterparties that interoperate. This should include efforts to harmonise the rules governing cross-border transactions, so that market participants have equal access to CCPs.